Relationship between Average and Marginal Cost

1. Average Cost (AC): Total cost of production divided by the number of units produced; it is the cost per unit of output.​
2. Marginal Cost (MC): The additional cost incurred in producing one extra unit of output.​

Both AC and MC are usually shown as curves (functions of output) in the short run and typically have a U-shape.​

Analogy (marks example)

• Think of AC as the average marks of a class and MC as the marks of one new student who joins the class.
• If the new student’s marks are below the class average, the class average falls; if above, the average rises; if equal, the average stays the same.
• In cost terms, MC plays the role of the “new student”, and AC is like the “class average”.

Production example (optional to add in your material)

• Consider a small factory making pens. As it increases output, the extra cost of each additional pen (MC) may first be lower than the current average cost (AC) and later become higher due to crowding, overtime, etc. This change explains the U-shape of AC and MC and their relationship.​

A] Three basic cases

1. When MC < AC

• Each additional unit costs less than the current average cost.
• This pulls the average cost down; hence, AC falls as output increases.
• On the diagram, MC lies below the AC curve, and in this region the AC curve slopes downward.​

2. When MC > AC

• Each additional unit costs more than the current average cost.
• This pushes the average cost up; hence, AC rises as output increases.
• On the diagram, MC lies above the AC curve, and in this region the AC curve slopes upward.​

3. When MC = AC

• The additional unit costs exactly the same as the current average cost.
• The average cost becomes constant at this output level.
• This point is the minimum point of the AC curve, and the MC curve cuts the AC curve at this point from below.​

Exactly the same logic holds for Average Variable Cost (AVC):

• MC < AVC → AVC is falling;
• MC > AVC → AVC is rising;
• MC = AVC → AVC is at its minimum point.​

• The rule “MC < AC → AC is falling” is only about the direction of AC, not about whether MC itself is rising or falling.
• Even when MC is less than AC, MC may be decreasing or increasing; as long as MC remains below AC, AC will continue to fall.
• Therefore, from the movement of AC alone, one cannot conclude the direction of change of MC; one only knows whether MC is above, below, or equal to AC.​

Use the letters M (for MC) and A (for AC):

• M > A → A rises (MC greater than AC, AC increases).
• M < A → A falls (MC less than AC, AC decreases).
• M = A → A constant at minimum (MC equal to AC, AC is at its minimum).​

This rule is very useful in solving MCQ and graphical questions quickly.

• AC is cost per unit; MC is cost of one extra unit of output.​
• Both AC and MC curves are generally U-shaped in the short run.​
• When MC lies below AC, AC falls; when MC lies above AC, AC rises.​
• MC cuts AC at the minimum point of the AC curve, from below.​
• The same relationship holds between MC and AVC.